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Market Misreads Trump Risk to Iranian Oil

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Just days before US President Donald Trump decides the fate of the nuclear deal with Iran, oil markets already appear to have priced in some disruption to Iran's 2.5 million barrels per day of liquids exports, judging by the surge in oil prices to $75 per barrel last week, the highest level since 2014. Speculators may be misjudging the situation. PIW analysis, informed by conversations with many of the biggest buyers of Iranian crude, shows a wide range of outcomes for physical disruptions, but almost none will happen right away. The worst-case scenario, involving strict, focused sanctions enforcement by the US, can knock out almost 700,000 b/d, while a less disciplined return of sanctions will hit under 200,000 b/d. If Trump walks away from the deal, according to the most aggressive enforcement case modeled by Energy Intelligence's Research & Advisory unit, European buyers, which have been taking over 500,000-600,000 b/d, would reduce their imports by more than 60%. Those levels are achievable, buyers tell PIW, pointing to Iraqi barrels as an easy substitution. Europe may even cut more than that. Total and Eni, two of the largest buyers, have significant exposure to the US and may decide against lifting any Iranian barrels at all (PIW Apr.30'18). European merchant refiners, which sources say take only one cargo per month, may decide the same. In this aggressive case, Asian buyers would reduce by 20%-40%. In a second scenario, lack of clear guidance from the US means European firms would make few changes to purchases in 2018. Asian buyers would take only slightly less or, in China's case, shift trade to more opaque shell companies that are harder to sanction. All the focus has been on Trump's pending decision and the magnitude of the disruption, but the real wildcard is the timeline. Under almost any scenario, exports will not grind to a halt in May. It will take at least six months to negotiate with Washington and wind down imports, making November the deadline to watch. At that point, Iran could already be struggling to sell some cargoes, but the market will not feel the heaviest blow until mid-2019, given the vagaries of sanctions and the uncertainty around how Trump will enforce them. The sanctions that expire in May blacklist any financial institution that conducts a petroleum-related transaction in any currency with Iran's central bank, the clearinghouse for most of Iran's oil sales, but it allows firms to seek exemptions if they "significantly reduce" crude purchases. The Obama administration used an unofficial reduction target of 20%, but Trump could interpret "significant" however he likes. Critically, the statute requires that buyers demonstrate "significant" cuts every 180 days. In a more chaotic and gradual rollout of sanctions, the market would lose 180,000 b/d, but not until end-2019. A third, perhaps less likely, scenario, envisioning coordination between the US and Europe, would see 350,000 b/d disrupted in mid-2019. The sheer number of variables and the big volumes at stake present a volatile landscape for oil markets. After Trump's decision day by May 12, the expected lack of short-term disruptions could be bearish, given the unprecedented speculative bets on a higher price for both West Texas Intermediate and Brent futures. However, the prospect of a major Iranian disruption at the end of the year and into 2019, when markets are expected to be even tighter thanks to Opec, could send prices skyrocketing, especially if Venezuelan output craters by another 500,000 b/d. Saudi Arabia has made it clear it wants to keep the Opec/non-Opec deal until the end of the year, and PIW balances show supply nearly 800,000 b/d below demand in the fourth quarter -- without factoring in an Iranian disruption (PIW Apr.30'18). The Saudis have indicated that they see little reason to prevent prices from rising. That sets up a potential showdown with Trump, who has complained about high prices and has the power to tailor sanctions in response to market conditions. It means another layer of uncertainty over whether he'll turn the screws on Iran -- and risk hurting his party in November's midterm elections.

Topics:
Oil Supply, Security Risk , Sanctions
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